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Releasing Oil From the SPR - A Desperate Economic Fix as QE2 Comes to an End?

The International Energy Association (IEA) announced a plan on Thursday last week to make 60 million barrels of oil available to the market over the next month from the Strategic Petroleum Reserve (SPR), in response to the disturbance in supplies from Libya. Half of this oil is to come from the SPR of the United States; the rest is to come from SPRs of other members of OECD.

Both the amount and the timing of the release are strange. The amount of the release is equivalent to 2 million barrels a day. This is actually more than the Libyan disruption took off the market, which was about 1.4 million barrels a day. The disruption first took place in February, and oil prices have been declining since early May, so the timing is strange, as well.

Figure 1 - Brent oil price since January 2007

What the timing of the oil release is close to, is the end of Quantitative Easing 2 (QE2). QE2 is the United States’ program of buying back debt to keep interest rates low and the dollar low, which began November 2010 and is scheduled to end June 30, 2011. It was intended to stimulate the economy, and oil prices have indeed risen during most of the time it was in effect.

Thursday’s announcement of the SPR oil-release program was made by IEA, but a person can’t help but wonder if the United States wasn’t heavily involved in the decision. After all, the United States is the largest member of the IEA, and is making half the release itself. Also, when Ben Bernanke spoke on wednesday, he didn’t have any financial replacement for QE2. The release of oil from the SPR looks as if it is the latest attempt to kick-start the economy, both of the US and other OECD countries, using yet another approach.

If we look at oil price and the S&P 500 Index (Figure 2), there has been a significant correlation between the two since late 2008. When oil prices drop, so does the S&P 500 Index, most likely since this means the economy is “tanking.” When oil prices rise, so does the S&P 500 Index, indicating the economy is working well.

Figure 2. Brent Oil Price and S&P 500 Index

The problem is that high oil prices soon sow the seed of their own destruction. Once the oil price starts getting high (over $85 is high, over $110 is very high), the high oil prices start causing recessionary influences, because citizens have to cut back on other goods, when oil and food prices start rising. Oil and food prices usually rise and fall together, because a lot of oil is used in food production.

No doubt one thing Ben Bernanke and other government officials are worried about is a repeat of the 2008 recession, or even worse. Their thought would seem to be, “If we can only get the oil price down, maybe it won’t sink the economy again.” If we look at US’s external debt (Figure 3), it started shooting upward, just as high oil prices became unsupportable by the economy in July 2008.

Figure 3. Average quarterly oil price and US Federal Debt

No doubt Bernanke and others have figured out the obvious–the United States is not in good enough shape financially to attempt another stimulus program, if recession hits again in full force. Letting oil out of the SPR would be a different way of perhaps getting the oil prices down, that wouldn’t “kill” the economy in the process.

What is good and bad about this approach?

The Good: Our real problem today is that we have extracted most of the easy-to-extract oil, and what is left is the expensive-to-extract oil, whose high price tends to kill the economy. The good thing about the SPR oil release plan is that it covers up our real problem for a bit longer, allowing the government to “kick the can down the road” further. Our huge debt problem is becoming totally unaffordable, especially if we should have to pay reasonable interest rates. This oil-release plan may stimulate the economy without borrowing, because with less expensive oil and food, buyers will be able to continue to make discretionary purchases, and business profits will look better. Voters are likely to be happy, too.

The Bad: The bad part about the SPR oil-release plan is that it tends to make the real problem of inadequate supply of inexpensive oil worse, long-term. The only way we get investment for more oil is through continuously high prices (and not too high tax rates). If we lower oil prices or raise tax rates on oil companies,we tend to choke back investment in oil. This makes oil prices higher in the long run. The only alternative to high oil prices is major economic contraction, because the economy can’t afford the high oil prices, and it can’t afford getting along without oil, because we need oil for cars, and trucks, and construction equipment, and for growing food, and for many other things.

One approach that might have helped, especially if we had started earlier, is more research on ways to extract heavy oil using less energy (and hence less CO2) in the process. We know that there is a great deal of heavy oil available, including some in the United States. If we had a way to get an adequate quantity of heavy oil out, in a way that didn’t send price too high, we would be in better shape from an oil supply point of view. (But probably not from a CO2 point of view).

Unfortunately, if high cost oil is what sinks the economy, high cost green energy is of very little help. We have been misled in this regard. It doesn’t even matter if the government provides a subsidy for expensive green energy–it still comes back around to sink the economy, because higher taxes are needed–either that, or it adds to the overly burdensome debt situation. Once citizens are charged higher taxes, the effect is very much the same as if citizens had paid the high prices to begin with–it reduces their discretionary income, and thus tends to be recessionary.

The government and the media have not been telling us the truth, in several respects:

1. The quantity of green energy that is made today is very low, and most of it is expensive. It can in no way power all of our cars and trucks and farm equipment. Most green energy provides expensive intermittent electricity, which is not helpful in powering equipment that operates on oil. There is no way we can transition to green energy in any reasonable time frame.

2. The problem with high oil prices is likely not to go away in one month or twelve months, unless we sink deeply into recession. Because of this, as soon as the SPR oil-release program is discontinued, we are likely to have the oil price problem back again. A one month reprieve doesn’t get us very far.

3. The story about Saudi Arabia and OPEC being able to ramp up their production is mostly just that–a story. Maybe Saudi Arabia has a little heavy, sour oil to put on the market, but the stories about its huge spare capacity, and its ability to ramp up supply, should be taken with a grain of salt. Looking at a graph of OPEC’s historical oil production compared to oil price suggests that they simply lower production when price is not high enough.

We have a lot of difficult choices ahead. Carbon emissions are a problem. We can get along without fossil fuels if we do things as our forefathers did. We probably can’t grow as much food, or support as large a population, though. So making a change of this type would be very difficult.

We don’t really have any green energy alternative that we can easily slide over to. There is some chance this option may be available in 50 years, but it isn’t available to a significant extent now.

The only other way of getting off oil seems to be deep recession, and nature provides it for us, as a by-product of high oil prices. If people don’t have jobs, they can’t afford to buy goods made with oil, so they use less. Governments find themselves in poor financial condition, so cut back programs, also reducing oil use. Those who are working find themselves with lower salaries and higher taxes, so they also cut back also.

Bernanke and others are doing their best to keep the economy going a bit longer. We can cross our fingers that the SPR oil-release program will work for a bit, but we shouldn’t kid ourselves that it will in any way fix the economy’s underlying problems.

By. Gail Tverberg

Gail Tverberg is a writer and speaker about energy issues. She is especially known for her work with financial issues associated with peak oil. Prior to getting involved with energy issues, Ms. Tverberg worked as an actuarial consultant. This work involved performing insurance-related analyses and forecasts. Her personal blog is ourfiniteworld.com. She is also an editor of The Oil Drum.

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Absolutely excellent and informative. About the SPR, I cant figure that out, nor do I know what OPEC is thinking just now, but even so I am happy.Why am I happy? I am happy because OPEC may have decided that it is not in their interest to play hardball at the present time, given the widely advertised weaknesses in the global macroeconomy.

Anonymous on June 28 2011 said:

Why do the graphs in the article show the price of crude rising again, while the graph at the top left of the webpage shows the price falling?

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